Abstract:
1. Introduction
Many banking processes are now fully automated for convenience, and
financial innovation is increasingly recognized as a catalyst for economic
growth. Yet, its mediation effect between bank performance and economic
growth remains underexplored, particularly in developing economies like
Sri Lanka. Hence, this study mainly investigates the mediation effect
through financial innovation on the effect of banks’ performance on
economic growth and also evaluates the direct effect, as previous studies
have reported conflicting findings on its direct impact.
2. Research Methodology
To enrich the findings, the researcher used the quantitative method. The
independent variable is banks' performance, measured by their lending
capacity, while the dependent variable is economic growth, measured by
GDP growth. Financial innovation, measured through innovation
specificity, serves as the mediator variable. The secondary data was
collected through annual reports of sampled banks in Sri Lanka, World
Bank, and Trading Economics indicators from 2011 to 2023. The sample
size is restricted to 12 banks, as some banks were excluded due to data
unavailability. The Structural Equation Model (SEM) is applied to assess
both direct and mediation effects, with the Sobel test (1982) used to
determine the significance of the mediation effect.
3. Findings and Discussion
The findings revealed that banks’ performance has a significant positive
effect on economic growth, confirming that banks' performance and
economic growth are mutually supportive in the Sri Lankan context.
However, there is an insignificant mediation effect through financial
innovation because of the limited innovation literacy and inadequate
evaluation of innovative projects.
4. Conclusion and Implications
In conclusion, banks must ensure rigorous appraisal processes when
investing in financial innovations and take necessary actions to enhance
customers' innovation literacy to foster greater engagement with
innovative financial solutions. It helps to assess whether these innovations
genuinely benefit the economy rather than just the banks, which could
improve the quality of financial innovation over time.
